The Benefits of Tax-Free Savings Accounts
Since 2009, Canadians ages 18 and older have had the benefit of contributing to a tax-free savings account (TFSA). The introduction of TFSAs marked an important milestone in the accessibility of savings vehicles for Canadian citizens. If you’re not already taking advantage of a TFSA, here’s what you should know about the benefits and limitations.
If you deposit funds into a TFSA, you are able to invest that money without taxation on the interest you earn over the lifetime of the investment. Any interest, dividends, and capital gains from the money in your TFSA will remain tax-free for life, even when you withdraw it. You can generally withdraw funds for any reason at any time, depending on the type of investment. Unlike a registered retirement savings plan, you don’t have to wait to use the money in your TFSA if you need it.
Consider this example of how individuals may benefit from a TFSA: At the beginning of the year, two people invest $5,000 in mutual funds earning 12% per year. Person A opens a regular investment account and Person B opens an investment account within a TFSA. Both accounts will have $5,600 at the end of the year. But if Person A wants to withdraw their funds, they’ll be taxed on the $600 they earned in capital gain. Person B will be able to withdraw the full $5,600 with no tax penalty.
TFSA Contribution Limits
There are limits to how much you can contribute to a TFSA. In the years 2019 and 2020, the annual limit for contributions is $6,000. The total limit to how much you can contribute, however, depends on your history of contributions to a TFSA since turning 18. The limit of funds that you can contribute is called your “contribution room.” Whether you’ve had money in a TFSA or not, you’ve been accumulating contribution room every year since 2009 that you’ve been 18 or older and a resident of Canada.
Say you turned 18 in 2006, but you didn’t start contributing to a TFSA until 2012. The annual contribution limit from 2009-2012 was $5,000, so when you start contributing in 2012, you’ll have a total limit of $15,000 ($5,000 for each of the three years you were not contributing). Unused contribution room carries over from one year to the next, so if you invested $10,000 in 2012, you’d have carried over $5,000 of room to 2013. In 2013, the limit increased to $5,500, so you would have had contribution room totaling $10,500 that year.
The annual contribution limit remained at $5,500 from 2013 to 2018, except for 2015 when it was $10,000. To put things in perspective, if you turned 18 prior to 2009 and you haven’t yet contributed to a TFSA, your total contribution room for 2020 is $69,500.
If you over contribute to a TFSA, the Canada Revenue Agency will impose a 1% tax for each month or partial month the account remains over the contribution limit.
As mentioned above, you can withdraw money from your TFSA for any reason at any time, as long as it’s permitted by the type of investment you’re funding. Any withdrawals also will increase your contribution room for the year following the withdrawal. For instance, if you withdraw $2,000 in 2020, you can add $2,000 to your contribution room for the year 2021. This room won’t count towards your contribution limit for 2020, however, so if you’ve already contributed your $6,000 limit, you will have to wait to contribute more.
TFSAs are a great resource for Canadian citizens to take advantage of. Always consult a financial professional if you’re unsure of the tax or financial implications of any investment.
*This content is developed from sources believed to be providing accurate information. The information provided is not written or intended as tax or legal advice and may not be relied on for purposes of avoiding any Federal tax penalties. Individuals are encouraged to seek advice from their own tax or legal counsel. Individuals involved in the estate planning process should work with an estate planning team, including their own personal legal or tax counsel. Neither the information presented nor any opinion expressed constitutes a representation by us of a specific investment or the purchase or sale of any securities. Asset allocation and diversification do not ensure a profit or protect against loss in declining markets. This material was developed and produced by Advisor Websites to provide information on a topic that may be of interest. Copyright 2021 Advisor Websites.